Latest round of deposit rate increases portends parallel rise in mortgage rates Hong Kong homeowners should by now be braced for a steady rise in their monthly mortgage repayments as banks begin to raise lending rates. The signal that such rises were imminent came last week with a round of deposit rate increases - a traditional precursor to a parallel rise in lending rates. For those who disregarded the signs and borrowed to the hilt based on present repayment levels, the long-awaited turn in the rate cycle could deliver some nasty surprises, the worst case being forced into default on loan repayments and losing their homes as a result. But if the outcome is a rise in loan delinquency as over-borrowed homebuyers throw in the towel and allow banks to repossess the collateral they hold on their loans, lenders themselves should shoulder some of the responsibility. Not only because they willingly funded the debt splurge, knowing that rates were due to rise, but also because they failed, when the opportunity was available, to introduce fixed-rate mortgages to insulate vulnerable buyers from the effects of those rising rates. The government should take part of the blame for its mixed signals on the debt level with which it was comfortable in the property market. We have had the Hong Kong Monetary Authority nominally enforcing a prudential guideline that loan-value ratios should not exceed 70 per cent. Meanwhile, its sister agency, the Hong Kong Mortgage Corp (HKMC), ratcheted up the cover it provided on loans exceeding this guideline, to the point where loan-value ratios in practice reached 90 per cent and more. So what are the prospects of a sharp jump in bad loans now that rates are due to go on the march? Bad loans, the saying goes, are made in good times; and for Hong Kong homebuyers the times have never been better owing to the cash that has been sloshing about in the system, the mortgage price war between lenders, and those mixed policy signals from the government which appear to have had more to do with helping property developers dispose of their stock, than with prudent policing of consumer debt levels. That excess liquidity has combined with policy to effectively subsidise Hong Kong homebuyers by keeping a lid on rate rises and shielding the money market from the rises in US rates, as well as promoting high levels of indebtedness. But with that liquidity now drying up (some argue it may return if speculation on the yuan resumes), rates have begun playing catch-up and the best guesses of analysts is that Hong Kong's prime lending rate should eventually catch up with the US benchmark lending rate, which continues to rise steadily. That implies a jump in the prime lending rate towards 8 to 9 per cent over the next 18 months or so. And that, in turn, implies a rise in home loan repayments of some 26 per cent or so - an increase that could prove unmanageable for many homebuyers given the limits to which they borrowed. The events highlight once again the puzzling absence in the banking market of a competitive fixed-rate loan product of a reasonable duration - the HKMC provides a limited tranche of three-year fixed-rate loans, but at a steep premium to floating rates that effectively rules out its appeal. But, had banks used the window of opportunity available to them as Hong Kong dollar rates were still headed downwards last year - despite the US rates having begun moving upwards - they might have raised fixed-rate funds at a modest price for, say, five years, and used the money to offer fixed-rate mortgage loans. The exercise requires less creativity and fewer bells and whistles that banks have routinely applied in recent times to manufacturing the structured note products that have become so popular in the market. Excuses that it couldn't be done because of the complexity required in hedging away such risks as early redemption of loans simply won't wash. Five-year money - equal, more or less, to the average duration of a parcel of home loans - might then have been raised at a modest premium to prevailing Hong Kong government paper in the market, and structured into a fixed-rate home loan costing a borrower about 3.5 per cent. Higher, to be certain, than the 2.5 per cent or so at which home loans were being made at the time, but near enough to be appealing to the savvy buyers who understood that prime lending rates, once they began moving again, were most likely destined to hit 8 per cent or above and in reasonably short order. Today, with rates on the rise, such an issue is more likely to require a bank to pay an interest coupon of 5 per cent or above, pricing the prospective fixed-rate loan at well above current floating rates. As with the current limited HKMC fixed-rate product, there wouldn't be too many takers at such a premium. Both borrowers and lenders may come to rue the missed opportunity.